The Bankers Investment Trust — Outperforming benchmarks old and new

Global stock markets have largely recovered from the wobble they experienced in the first quarter of 2018, with the UK FTSE 100 index flirting with a new all-time high. As seen in Exhibit 2 (left-hand side), however, the gap that opened up between the UK and global markets in the period of sterling weakness following the EU referendum in mid-2016 is yet to close, with the FTSE All-World index total return outperforming the FTSE All-Share in sterling terms over one and two years to 16 May 2018, as well as over the five-year period shown. This is in spite of a stronger pound versus the US dollar over the past 12 months, and illustrates the potential benefits to UK-based investors of allocating some of their investments to overseas markets.

Valuations across the majority of global markets remain high relative to history (right-hand table), with only Japanese equities currently trading on a 12-month forward P/E ratio below the 10-year average. While European stocks currently look the most elevated in terms of valuations versus the 10-year average, it is important to note that Europe ex-UK has the lowest 10-year average forward P/E, a hangover from the eurozone crises of 2011-13. The US, meanwhile, has fallen back somewhat from the 10-year high of 18.9x forward earnings seen just before the market sell-off in February, although it has the highest average forward P/E overall. While stronger earnings growth in 2017, and continuing into 2018, to some extent supports these higher multiples, investors may wish to take a more valuation-aware approach in order to avoid pockets of overvaluation.

BNKR is one of the UK’s oldest closed-end funds, launched in 1888 and celebrating its 130th anniversary this year. The trust invests in global equity markets with the aim of achieving capital and income growth, and is managed by Janus Henderson Investors (JHI). Lead manager Alex Crooke, who was recently appointed as JHI’s co-head of equities, has been in place since 2003 and oversees a group of regional portfolio managers, as well as working with the board to set the overall geographical allocation and the level of gearing (permitted up to 20% of net assets).

The trust has recently changed its benchmark and the wording of its investment objective in order to add clarity (it was felt that a global index was more appropriate for a global fund), although its approach remains unchanged. With effect from 1 November 2017, the benchmark has switched from the FTSE All-Share index to the FTSE World index. While the investment objective was previously to achieve long-term capital growth in excess of that of the All-Share index (thereby compensating investors for the extra risk of investing outside the domestic market), it is now to achieve long-term capital growth in excess of that of the FTSE World index. The objective of providing annual dividend growth in excess of RPI inflation remains unchanged. BNKR has the second-longest record of unbroken annual dividend growth for a UK investment trust, having raised its dividend in each of the last 51 years.

After a strong run in global stock markets over the past 12 months (notwithstanding increased volatility of returns so far in 2018), Crooke is more circumspect on the near-term prospects for equities. While there may still be value in out-of-favour UK names, he says US stocks in particular are in need of repricing, even after a degree of re-rating following the market sell-off in February and March. “Although I don’t see a crash, at these P/E valuation levels I can see the US underperforming other markets over the next three years,” he explains. He contrasts the US – where ‘financial engineering’ measures such as share buybacks, and the one-off impact of tax cuts, have made a notable contribution to company earnings growth and share prices – with Europe, which tends to be more cyclical, and offers significant catch-up potential given its economic recovery has lagged that of the US by several years. US corporate earnings also recovered more sharply and more quickly than those in Europe following the global financial crisis, having previously moved more or less in tandem. Meanwhile, with earnings growth in Japan forecast to accelerate in 2018 after an already strong year in 2017, Crooke views the market’s combination of growth, corporate reform, loose monetary policy and low valuations vs global indices as attractive.

Global economic growth figures remain encouraging and employment numbers are strong, yet inflation remains low at c 0-2% across most developed markets. Crooke says that with fixed income investments looking less attractive against a backdrop of (albeit slower than forecast) rising interest rates, even a modest increase in inflation would make equity markets seem the obvious choice for investors seeking real returns. However, the manager sounds a note of caution, particularly with regard to technology companies. Tech stocks are now at their highest percentage share of the US equity market since the TMT bubble of the early 2000s, at c 25%, and the weighting of technology stocks in emerging markets is close to its highest level ever, at nearly 30%. While Crooke says he is not calling the top, historically sectors that reach such dominant levels have been vulnerable to periods of relative underperformance. With this in mind, BNKR has been taking profits in tech names such as Samsung and Amazon, although the trust’s exposure to the sector as a whole is relatively limited owing to a combination of high valuations and low dividend yields.

Crooke sets the geographical allocation for BNKR, with the regional portfolios all being managed by specialists at Janus Henderson Investors. While each manager has their own approach, the overall investment style for the BNKR portfolios is bottom-up and tilted towards value and income, with a preference for cash-generative companies whose dividend growth can support BNKR’s own impressive record of growing dividends year-on-year. As shown in Exhibit 3, in sterling terms all the regional portfolios outperformed their reference indices in FY17, with the exception of the UK, where underperformance was marginal.

Key details of each regional portfolio at 31 October 2017 are shown below.

At 30 April 2018, there were 192 stocks in the BNKR portfolio, a reduction from 203 a year earlier. The majority of the regional sub-portfolios contain between 10 and 40 stocks, with the exception of the UK (68 stocks at end-FY17), historically the largest weighting, but now second behind North America having fallen by 2.2pp over 12 months (Exhibit 4). In line with the large number of stocks in the portfolio, concentration in the top 10 holdings is low, at 14.2% (14.5% at 30 April 2017).

As seen in the table above, North America is well below and the UK is well above the new FTSE World index benchmark weighting (previously FTSE All-Share). It is unlikely BNKR’s US exposure will converge with that of the index, given the dominance of highly valued, low-yielding tech stocks in the US index. The portfolio is also overweight Pacific ex-Japan, principally because of the exposure to China (c 10% of the portfolio in early 2018 including Hong Kong-listed Chinese stocks), which is excluded from the index. Crooke says that after the strong performance of the China ‘A’ share portfolio in FY17, he is happy not to add to the current weighting until manager Charlie Awdry sees a broader range of attractively valued stocks. However, over time the exposure to China could rise further. The UK weighting is down over the past year, having already been reduced in the previous 12 months from more than 30%. Though historically an important source of dividends, Crooke says he is now comfortable looking further afield for yield, with both Europe and Asia offering dividend yields at a similar level to the UK. The shape of the UK portfolio has also shifted somewhat over the past year, with more emphasis on mid-cap stocks such as Pets At Home, Victrex and Ted Baker.

Sector weightings (Exhibit 5) are broadly stable over the past 12 months, although there is a large overweight in consumer goods companies versus the index. Financials remains the biggest weighting, in line with Crooke’s prevailing view of ‘value’ as being stocks with underappreciated cash flows, rather than simply those whose P/E or price/book valuations are low relative to their history. He comments that banks are getting to a position where they no longer have to rebuild their capital bases, meaning they have more scope to share their cash flows with shareholders. Gearing remains relatively low at c 4.0% versus a normal working range of up to 10%. Crooke comments that with valuations heading upwards for most of the past year, he had not felt it was the right time to be aggressive with BNKR’s gearing; however, he is alert to opportunities in cheaper value stocks and may increase gearing as a result.

BNKR’s performance has bounced back following the market sell-off in early 2018, and share price and NAV total returns are both well ahead of the blended benchmark over 12 months to 30 April (Exhibit 6). Over longer periods, annualised NAV total returns of c 9-12% are well ahead of the benchmark (FTSE All-Share index until 31 October 2017 and FTSE World index thereafter), while share price total returns are slightly higher as the discount to NAV has narrowed. As shown in Exhibit 7, returns relative to the FTSE All-Share index over longer periods far outstrip returns versus the new FTSE World index benchmark, reflecting lacklustre UK market performance relative to the rest of the world. However, BNKR’s returns still exceed those of the global index over the majority of periods shown. The allocation to China (not included in the FTSE World index) is an important element in BNKR’s performance on both an absolute and relative basis. Exhibit 8 illustrates the relatively low volatility of the trust’s NAV outperformance versus the blended benchmark, notwithstanding a more volatile period around the time of the UK’s EU referendum in mid-2016.

At 24 May 2018, BNKR’s shares traded at a 1.2% discount to cum-income NAV. This follows a sustained narrowing in the discount since mid-2017 (Exhibit 9), coinciding with a period of strong NAV and share price performance, and compares with average discounts of 2.1%, 3.5%, 2.9% and 6.5% respectively over one, three, five and 10 years. The trust has the authority to buy back or allot shares to manage a discount or premium, but there is no stated discount or premium level at which this would occur, and no shares have been issued or repurchased since October 2016.

BNKR is a conventional investment trust with one class of share. At 24 May 2018, there were 122.6m ordinary shares in issue, unchanged over 12 months. Structural gearing is in place through a £50m issue of 20-year loan notes (maturing in 2035 with a fixed coupon of 3.68%), and a £15m debenture with an interest rate of 8%, maturing in 2023. Together these equate to gross gearing of c 6.2%, but this is partly offset by cash, meaning net gearing stood at 4.0% at 30 April 2018.

Janus Henderson Investors is paid a management fee of 0.45% of the first £750m of net assets and 0.40% thereafter. There is no performance fee. For FY17, ongoing charges were 0.44%. However, this reflected a period following the Henderson Global Trust rollover and a change in the calculation basis (see our March 2017 note) when fees were capped at £843,685 per quarter, effectively lowering the annual management fee to c 0.31%. The fee cap was removed as of the end of calendar 2017. Based on current net assets and assuming the level of other expenses remains constant, we calculate that ongoing charges for FY18 could be c 0.50%.

BNKR has the second-longest record of uninterrupted dividend growth for an investment trust, having increased its payout in each of the last 51 years. Dividends are paid quarterly, in May, August, November and February. For FY17 (year ended 31 October), total dividends of 18.6p were paid, ahead of the guidance at the start of the year for at least 18.0p, and a year-on-year increase of 9.4% on FY16’s 17.0p, well ahead of the rate of inflation.

So far in FY18, one interim dividend of 4.86p has been declared. If this level is maintained throughout the year, total dividends would be at least 19.44p, an increase of 4.5% on FY17. However, given the strength of BNKR’s revenue reserve (1.8x the cost of the FY17 dividend at the year-end), the board has forecast that dividend growth should be at least 6.0% for FY18, suggesting total dividends for the year of 19.7p or more. BNKR’s dividend has been fully covered by income in 10 of the last 11 years (the exception was FY11). Based on the last 12 months’ dividends, BNKR’s shares yield 2.2%.

BNKR is classified in the AIC Global sector, a group of 21 funds containing many of the longest-established investment trusts. The sector has reduced in size somewhat in recent years as several multi-asset trusts have moved to the Flexible Investment sector, meaning the majority of the remaining peers are now diversified global equity funds like BNKR. Exhibit 10 below shows the 11 largest trusts in the sector, all of which have assets of more than £500m. Within this group, BNKR ranks fourth, seventh, sixth and sixth respectively for NAV total return performance over one, three, five and 10 years. Taking the sector as a whole, BNKR ranks ninth, 11th, 10th and 11th for NAV total returns over the same periods. Ongoing charges are among the lowest both in the subset of large trusts and the wider sector, and there is no performance fee. Gearing is below average, while the dividend yield is the third highest of the large trusts and fifth highest overall. BNKR currently trades close to NAV, compared with a small discount on average for the whole sector.

There are four independent, non-executive directors on BNKR’s board. Richard Killingbeck joined the board in 2003 and became chairman in 2013. Susan Inglis, the senior independent director, was appointed in 2012, with Julian Chillingworth joining the board in 2015. The newest director, Isobel Sharp, was appointed in October 2017 and became audit committee chair on the retirement of Matthew Thorne at the February 2018 AGM. David Wild also retired as a director at the 2018 AGM. The directors have backgrounds in fund management, corporate finance and accountancy.

BNKR has a listing on the New Zealand Stock Exchange, and Exhibits 11 and 12 show the trust’s performance in New Zealand dollar terms. Over five years the NZ dollar is broadly stable against sterling, illustrating the tendency of currency movements to even out. Over the past 12 months, NZ dollar investors have seen share price and NAV total returns of 19.5% and 15.6% respectively, compared with 14.9% and 11.4% for sterling investors, as the pound strengthened. Conversely, over three years, share price and NAV total returns to NZ dollar investors were lower, at an annualised 11.8% and 10.8% respectively, compared with 13.5% and 12.0% for sterling investors, reflecting the period of significant sterling weakness following the EU referendum in June 2016. This is even more visible in the table of discrete returns below, where over 12 months to 30 April 2017, the translation from a weaker sterling saw share price and NAV total returns for NZ dollar investors of 16.6% and 18.0%, compared with 33.7% and 31.2% for sterling investors.